From the launch of the reform and opening up policy in 1978 to the integration of the exchange rate regime in 1994, the average renminbi exchange rate against major trad ing partners both in terms of the nominal and real effective exchange rates fluctuated greatly, by 68 per cent and 76 per cent, respectively. However, this depreciation process was not basically completed until the breakout of the 1997 Asia crisis The most important message here seems to be that the official rate was politically determined and tended to be overvalued. However, this overvaluation, under an imperfect market, is only meaningful relative to the swap market exchange rate, and not to the fund amental factor-based exchange rate(see Chapter 5). Clearly, the politics behind the overvaluation must be that the government benefited from the overvaluation under the traditional system in the sense that foreign exchange revenue was forcibly sold to the PBOC. The overvaluation of the renminbi meant that the government could buy foreign exchange at a lower price. In other words, the central government was able to get extra tax" by overvaluing the renminbi However, taking a realistic account of the international competitiveness of the PRC economy, the trade related real exchange rate had to be set at a very low level to promote exports. Accordingly the depreciation pressure on the official rate was intensified. This shows that there was a contradiction between foreign trade development and exchange rate policy in the traditional system, which was not very easy to resolve 2 Integration of the exchange rate regime On 1 January 1994, the Pboc announced a reference rate for the renminbi against the USD, the Hong Kong dollar, and the Japanese yen based on the weighted average price of foreign exchange transactions of the previous day's trading, marking a new stage for the exchange rate regime. In accordance with the announcement, daily movements of the exchange rate of the renminbi against the USD were limited to 0.3 per cent on either side of the reference rate announced by the PboC. the buying and selling rates of the renminbi against the Hong Kong dollar and the Japanese yen were not permitted to deviate from more than l per cent on either side of the reference rate, in the case of other currencies, the deviations should not exceed 0.5 per cent on either side of their respective reference rates (IMF1997,p.196) When the renminbi exchange rate and foreign exchange swap market rate were integrated the official rate was 5. 8 and swap market rate 8.6. The integration of exchange rate made the official exchange rate depreciated by 33. 3 per cent. Taking account of the fact that 80 per cent of forex transactions at the time were done in the swap market, the real devaluation of the currency was 6.7 per cent. To elaborate the situation of exchange rate fluctuations after 1994, we divide this period into three different sub-phases the period of transition after integration from 1994 to 1997; the period of depreciation pressure after the Southeast Asian crisis from 1998-2001 and the period of appreciation pressure afterwards The unified exchange rate terminated the long-standing situation of the renminbi overvaluation and, thereby, reversed a persistent trend of decline. From 1994 to the end ofFrom the launch of the reform and opening up policy in 1978 to the integration of the exchange rate regime in 1994, the average renminbi exchange rate against major trading partners both in terms of the nominal and real effective exchange rates fluctuated greatly, by 68 per cent and 76 per cent, respectively. However, this depreciation process was not basically completed until the breakout of the 1997 Asia crisis. The most important message here seems to be that the official rate was politically determined and tended to be overvalued. However, this overvaluation, under an imperfect market, is only meaningful relative to the swap market exchange rate, and not to the fundamental factor-based exchange rate (see Chapter 5). Clearly, the politics behind the overvaluation must be that the government benefited from the overvaluation under the traditional system in the sense that foreign exchange revenue was forcibly sold to the PBOC. The overvaluation of the renminbi meant that the government could buy foreign exchange at a lower price. In other words, the central government was able to get extra “tax” by overvaluing the renminbi. However, taking a realistic account of the international competitiveness of the PRC economy, the trade related real exchange rate had to be set at a very low level to promote exports. Accordingly the depreciation pressure on the official rate was intensified . This shows that there was a contradiction between foreign trade development and exchange rate policy in the traditional system, which was not very easy to resolve. 2 Integration of the Exchange Rate Regime On 1 January 1994, the PBOC announced a reference rate for the renminbi against the USD, the Hong Kong dollar, and the Japanese yen based on the weighted average price of foreign exchange transactions of the previous day’s trading, marking a new stage for the exchange rate regime. In accordance with the announcement, daily movements of the exchange rate of the renminbi against the USD were limited to 0.3 per cent on either side of the reference rate announced by the PBOC. The buying and selling rates of the renminbi against the Hong Kong dollar and the Japanese yen were not permitted to deviate from more than 1 per cent on either side of the reference rate; in the case of other currencies, the deviations should not exceed 0.5 per cent on either side of their respective reference rates (IMF 1997, p.196). When the renminbi exchange rate and foreign exchange swap market rate were integrated, the official rate was 5.8 and swap market rate 8.6. The integration of exchange rate made the official exchange rate depreciated by 33.3 per cent. Taking account of the fact that 80 per cent of forex transactions at the time were done in the swap market, the real devaluation of the currency was 6.7 per cent. To elaborate the situation of exchange rate fluctuations after 1994, we divide this period into three different sub-phases: the period of transition after integration from 1994 to 1997; the period of depreciation pressure after the Southeast Asian crisis from 1998–2001 and the period of appreciation pressure afterwards. The unified exchange rate terminated the long-standing situation of the renminbi overvaluation and, thereby, reversed a persistent trend of decline. From 1994 to the end of